Originally Posted by MoonlightShadow
I have experienced the 1980s and 1990s recessions, here in the UK. But this one is so different . . . <snip>
Well, you've certainly got that right, MoonlightShadow - it is very
different, this time. This is no typical correction, no typical downturn in the business cycle. The world as we knew it is gone - there is no going back; no return to normality.
The problem is that we're inside a rickety old bus, careening down an iced-over highway from the summit of a high mountain pass in white-out conditions, with no guardrail, no brakes, no notion where the bottom is and the driver keeps announcing over the speaker that everything will be OK - if not immediately, then soon, or if not soon, then in the foreseeable future, at least, or if not then, uhm, probably not long after that.
Sounds pretty grim, doesn't it? Surely I'm exaggerating.
No, I'm not. There is a "problem" built-in to the system. It is a cancer and it has metastasized. It is called derivatives.
Derivatives have a notional value in excess of $600trillion. How much is that? Well, the total world-wide economy is about $60trillion. The GDP of the US is less than $15trillion. And just one small aspect of the derivative cancer is Credit Default Swaps - CDSs. They have a notional value of about $50trillion.
They came to be when someone got the bright idea of "insuring" against a default by a borrowing entity. Think AIG, or Citibank, or BofA collecting fees
to "guarantee" that if a borrowing entity defaulted on its credit, the buyer of the guarantee would be paid the full amount of the loan. So confident were these genius "insurers" that there would be no defaults, they sold the insurance
over and over again to anyone who wanted to buy it.
It was as if the lender on Joe's house down on the corner persuaded another bank to sell him insurance
that would pay him the amount of his loan if Joe stopped making his payments. The second bank was confident that Joe was a great risk with his high credit rating, income and history
of always making his mortgage payment. To this bank, the "insurer," this was easy money! So easy, they didn't even charge much premium.
Why, it was so easy that they didn't just sell the insurance to the original lender, they sold it again and again to anyone who, for a small premium, wanted to buy the same insurance. Then several other banks discovered this easy money and they began to sell insurance against a default by Joe, as well.
Joe's simple, little mortgage was now the epicenter of a brisk trade
in the selling of insurance against his ever defaulting. Entities with no stake in the original loan - who, therefore had no skin in the game
save their "insurance" premium - were gambling that Joe might indeed default on his promise to repay the loan. If he did, they would collect the entire amount of the loan, and, by now, there were hundreds - even thousands - who had an interest in whether Joe paid his mortgage or not - had, in fact, bet that he wouldn't.
Bad time to be Joe!
Now, instead of Joe, substitute Chrysler, for example, or GM or any other mega-corporation, and instead of one pathetic little mortgage, substitute the corporate debt of the mega-corp. Who can fail to see that the failure to repay this corporate debt, a default, will send those holding the winning tickets - the CDSs - straight to the pay-out window of the entities that wrote the "insurance." Do you think they might want to "encourage" the failure of mega-corp?
Problem! Those who wrote the insurance have but a fraction of the capital required to make good on all the insurance they sold - again and again and again . . . Once the Credit Default Swaps must be payed out, the nice little premium-collecting profit-center has become a catastrophic liability. Just one major default can bankrupt an insurer - no single
entity has the kind of capital required to pay the enormous losses.
Not even Uncle Sam.
Buying Credit Default Swaps on credit that you never had anything to do with providing, from an entity which, likewise, had nothing to do with providing the credit, turns out to have been the greatest lottery ticket available. For a few million dollars of premium per year, you stood to collect billions if the mega-corp you bet against defaulted.
It was like everyone in the neighborhood bought fire insurance on Joe's house, then did everything they legally could to encourage a big cook-out at Joe's, with fireworks and free matches for the kiddies, firewalkers, jugglers of flaming torches - well, you get the idea. Who knows what might happen?
For now, the US Treasury and the Fed will attempt to prop up all of the faltering entities - the mega-corps and the insurers - to delay for as long as possible what would seem to be the inevitable. The billions that are being thrown into the hole that is trillions of dollars
deep is only window-dressing designed to buy time. Behind the scenes, you can be sure that things are being considered that would never pass the laugh test in "normal" times.
It's just that times are no longer normal - and never will be again. The Credit Default Swaps represent less than 10% of the total derivative market, as I stated, yet they have the potential to annihilate the current
Imagine the destructive energy contained in the other 90%!
So, MoonlightShadow, you asked if the current crisis will effect cruising? Yes, absolutely, and everything else you know or think or believe to be true about capitalism!